Understanding Systemic Risk: The Trade-Offs between Capital, Short-Term Funding and Liquid Asset Holdings
Zhongfang He () and
Staff Working Papers from Bank of Canada
We offer a multi-period systemic risk assessment framework with which to assess recent liquidity and capital regulatory requirement proposals in a holistic way. Following Morris and Shin (2009), we introduce funding liquidity risk as an endogenous outcome of the interaction between market liquidity risk, solvency risk, and the funding structure of banks. To assess the overall impact of different mix of capital and liquidity, we simulate the framework under a severe but plausible macro scenario for different balance-sheet structures. Of particular interest, we find that (1) capital has a decreasing marginal effect on systemic risk, (2) increasing capital alone is much less effective in reducing liquidity risk than solvency risk, (3) high liquid asset holdings reduce the marginal effect of increasing short term liability on systemic risk, and (4) changing liquid asset holdings has little effect on systemic risk when short term liability is sufficiently low.
Keywords: Financial stability; Financial system regulation and policies (search for similar items in EconPapers)
JEL-codes: C15 C81 E44 G01 G21 (search for similar items in EconPapers)
Pages: 36 pages
New Economics Papers: this item is included in nep-ban, nep-bec, nep-reg and nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:10-29
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